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Safeway Slips to Neutral

On May 21, we downgraded our long-term recommendation on Safeway Inc. to Neutral from Outperform as this North American food and drug retail giant is showing signs of sluggish growth. The stock carries a Zacks Rank #3 (Hold).

Why the Downgrade?

On Apr 25, Safeway reported a weak first quarter which lagged our expectations. Despite earnings growth of 16.7%, adjusted earnings of 35 cents missed the Zacks Consensus Estimate by a penny. Revenues stood at about $10 billion, flat year over year, trailing the Zacks Consensus Estimate of $10.2 billion.

Margins were under pressure in the first quarter. Despite the benefit of New Year sales, identical store (ID) sales (excluding fuel) inched up 1.5% from the year-ago quarter. ID sales growth was negated by the disposition of Genuardi’s stores in 2012 and soft fuel sales.

On the positive side, Safeway gained market share with rising uptake of the “Just for U” loyalty program. We are encouraged by the company’s working plan to save costs and expand foothold in the U.S. healthcare market. The recent initiative of the sale of a minority stake in its subsidiary Blackhawk Network Holdings (HAWK - Free Report) should support improve Safeway’s focus on mainstream retail business.

However, a high debt level and lower income on account of Blackhawk offering adds to our concern. The company also faces a tough competitive landscape with other players recording healthy sales growth. While improving macroeconomic conditions are likely to boost growth for Safeway, any near-term comfort from ongoing headwinds is unlikely.

Other Stocks to Consider

While we have a neutral disposition on Safeway, other stocks such as Carrefour SA (CRRFY - Free Report) and The Kroger Co. (KR - Free Report) , carrying a Zacks Rank #2 (Buy) are worth considering.

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